18 Sep 2014

US "fraud on the market" rules to affect securities class actions?

by Patricia Paton, Stuart Byrne

The Camping Warehouse case might determine if the US "fraud on the market" principle is part of Australian law.

Securities class actions may be easier to prove if a recent court decision is followed through.

A person who suffers an investment loss because of another person's misleading or deceptive conduct has a right to recover that loss by taking action against that person (section 1041I of the Corporations Act).

The investor must establish that the wrongful conduct caused its loss. However there have been a number of cases in Australia which have fallen over because the investor has been unable to prove that it actually relied on the misleading conduct.

In the United States, the need to prove "reliance" on the misleading conduct is less of an issue. There, the "fraud on the market" principle creates a rebuttable presumption that the investor relied on the wrongful conduct.

Over the years there has a lot of debate about whether this "fraud on the market" principle does – or should – form part of Australian law.

In 2007, Justice Finkelstein of the Federal Court commented that the rebuttable presumption of reliance arguably applied in Australia (P Dawson Nominees Pty Ltd v Multiplex Ltd [2007] FCA 1061). Now we may find out whether what Justice Finkelstein said was true.

In Camping Warehouse Australia Pty Limited v Downer EDI Limited[2014] VSC 357, a class action is being mounted against a company for alleged breach of its continuous disclosure. The investors are arguing that certain information was not made generally available by the company, and that a reasonable person would have expected that the relevant information would have had a material effect on the price or value of the defendant's securities if that information had been made generally available.

Significantly, the investors are arguing that the continuous disclosure rules are so fundamental to an efficient market that investors only have to prove that the company breached them, and not, in addition, that the investors actually relied on that breach.

At a relatively early stage in the proceedings, the company asked the Court to strike out the application on the basis that the plaintiffs hadn't pleaded reliance.

The Court noted that previous cases which have upheld the need to prove reliance have not been concerned with alleged breaches of the continuous disclosure rules. Given that fact, and the comments of Justice Finkelstein, the Court thought it was at least arguable that the investors did not have to prove reliance in this case. Given that the proceedings were still at an early stage, the Court was not prepared to throw out the investors' case. Instead, the Court gave the plaintiff leave to amend its statement of claim and dismissed the strike-out application on the grounds that it is not beyond doubt that reliance is required, and it is only in the clearest of cases that a claim should be struck out:

"In my opinion a brief review of the legislation and authorities establishes, for the purposes of a strike out application, that the matter is far from clear and the plaintiff's case is not plainly hopeless…

…The plaintiff has pleaded that the conduct in breach of the Act caused the loss in the sense of the reduced value of the shares. The essence of the claim is that the shares when acquired were overpriced directly because of such conduct. It cannot be accepted that this formulation is plainly hopeless or bound to fail."

Of course, this only means that, when or if the matter goes to trial, the investors may be able to argue that they do not have to prove reliance. It is by no means certain that the Court will end up accepting that argument. Nevertheless, the Court's decision to allow the investors to press their claim is potentially important news for listed companies.

We will continue to follow this case and provide updates of any interesting developments.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.